Stability has been one of the most elusive economic goods. Despite more than a century of effort, economies remain prone to downturns, which often come after booms that proved unsustainable. Rich countries are currently stuck in one of the down periods, a seemingly endless Lesser Depression.
Economists argue about the details of what went wrong, but they often miss something basic: persistent instability is surprising. Surely, societies which summon enough economic ingenuity and organisation to develop smart phones, manage global supply chains and pay for a dozen years of universal education can manage to maintain a steady pace of overall economic activity? All that is required is the identification and early correction of imbalances, in both the real economy and the financial system.
In the pre-industrial age, good macroeconomic management was all but impossible. As long as agricultural activity was the economic mainstay, a poor harvest led not only to less food but to less spending by farmers. Their purchases of ploughs and shoe leather declined, even though a temporary spell of bad weather had no effect on production capacity.
Governments had neither the information nor the resources required to compensate. In any case, monetary counter-moves were impractical when the only reliable money was coins struck from a strictly limited supply of precious metals. Governments and banks could theoretically give farmers paper money to buy readily available goods, but the currency would not be trusted.
More recently, economic instability could be blamed on ignorance and immature institutions. In particular, the mechanisms of financial excess, the cause of most of the crises of the last century, were poorly understood. While economists knew that speculation was dangerous, their analysis was primitive. In addition, governments were slow to put detailed regulation of the financial system on their list of responsibilities.
Now, though, booms and declines are inexcusable. Farming plays a minimal role in advance economies, and no significant sector is subject to large natural variations of output. On the contrary, far more than half of GDP is spent on services, which tend to be purchased very steadily. Statistics are ample, so economists can easily identify anomalies. Governments are well informed, dominate the economy and have full monetary flexibility.
Twice in the last half-century, experts thought they had found the secret to good macroeconomic management. In the 1960s they put their faith in the “fine-tuning” of monetary and fiscal policy. In the 2000s, they saw a “great moderation” come from inflation targeting, relaxed central banks and unencumbered financial institutions. After the latest failure, the professionals have mostly fallen back to their previous belief in unavoidable cycles of exuberance and depression. Like mood swings in love affairs, economic ups and downs are considered unfortunate facts of life.
The defeatism is unnecessary. Motor vehicle fatalities provide a good precedent. Starting in the 1960s, a coordinated campaign, including both behaviour modification and improved engineering, has succeeded in reducing the death rate in the United States (as a fraction of the total population) by more than half. Economic deviations can be reduced by much more.
Drivers were cajoled to change their behaviour: stop drinking, wear seat belts and reduce speeds. Economic actors can also learn that excessive enthusiasm, like reckless driving, eventually leads to trouble. Anti-greed education can teach that immoderate financial gains are bad for society and are likely to be followed by even larger losses.
The lessons should be backed by corrective policies. The authorities must be committed to use regulation, taxes and fiscal and monetary policy to stomp hard whenever any significant financial and economic indicator moves in a dangerous direction. The short current watch-list of consumer inflation, GDP growth and unemployment should be lengthened to include the prices of property, debt, shares and commodities. Rates of change in lending and financial activity are also important.
The engineering of the financial and economic system needs the same sort of upgrade that car and road design got when safety became a higher priority. Errors, of both drivers and investors, are less dangerous on safer roads. The economic authorities should develop automatic stabilisers to limit herd behaviour. They have the tools. They can both create and destroy money and credit. In the face of mob gloom, they can create new jobs, either directly or indirectly.
Defeatism should be replaced by a firm commitment to economic safety. Sadly, there are few signs of such a change. For all the talk about “macro-prudential regulation”, economists and politicians are still reluctant to restrain financial dreams. Monetary authorities balk at taking full advantage of their powers.
Ultimately, something like moral cowardice lies behind this unnecessary restraint, and behind the recurrence of financial crisis. The pattern cannot be broken until the authorities decide to identify and attack reckless financial behaviour wherever it occurs. The failure is discouraging, but there’s no need to abandon hope. Like driver safety, and like the legal protection of workers and the restriction of pollution, economic stability is an idea whose time will come.